X-FAB Silicon Foundries (EPA:XFAB) Seems To Use Debt Rather Sparingly

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that X-FAB Silicon Foundries SE (EPA:XFAB) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for X-FAB Silicon Foundries

What Is X-FAB Silicon Foundries's Debt?

As you can see below, X-FAB Silicon Foundries had US$49.9m of debt at September 2021, down from US$106.2m a year prior. However, it does have US$226.0m in cash offsetting this, leading to net cash of US$176.1m.

How Healthy Is X-FAB Silicon Foundries' Balance Sheet?

We can see from the most recent balance sheet that X-FAB Silicon Foundries had liabilities of US$124.3m falling due within a year, and liabilities of US$36.4m due beyond that. Offsetting this, it had US$226.0m in cash and US$66.5m in receivables that were due within 12 months. So it actually has US$131.9m more liquid assets than total liabilities.

This short term liquidity is a sign that X-FAB Silicon Foundries could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that X-FAB Silicon Foundries has more cash than debt is arguably a good indication that it can manage its debt safely.

It was also good to see that despite losing money on the EBIT line last year, X-FAB Silicon Foundries turned things around in the last 12 months, delivering and EBIT of US$63m. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine X-FAB Silicon Foundries's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. X-FAB Silicon Foundries may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, X-FAB Silicon Foundries actually produced more free cash flow than EBIT over the last year. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While it is always sensible to investigate a company's debt, in this case X-FAB Silicon Foundries has US$176.1m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of US$64m, being 101% of its EBIT. So is X-FAB Silicon Foundries's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for X-FAB Silicon Foundries that you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.